Engine of Growth: Pratt & Whitney's geared turbofan commercial jet engine doesn't go into service until next year, but it has already generated a lot of interest from customers, in part because it's more fuel efficient than its predecessor. The company says the engine could generate more than $400 billion in sales over time.
Courtesy of United Technologies

But a little more than 18 months later, the Goodrich bet looks to be in the money, and UTC CEO Louis Chênevert is breathing a little easier. Goodrich is expected to add 55 cents a share to UTC's earnings this year, lifting them to an estimated $6.11 a share. It has given the conglomerate important new items to sell to aerospace customers worldwide and an imposing perch in the airline business. UTC can now supply two-thirds of the contents of a commercial airliner, almost twice what rivals
General ElectricGE -0.8558917197452229%General Electric Co.U.S.: NYSEUSD24.905
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(GE) and
Honeywell HON -0.2954913735582881%Honeywell International Inc.U.S.: NYSEUSD104.6
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(HON) can offer.

"Goodrich is done. It is working, and it has nice synergies," says Chênevert.

The Goodrich gains coincide with progress in other UTC aerospace units, including the long-awaited release of an innovative Pratt & Whitney engine and the first contributions from another 2011 airline-related acquisition.

United Technologies has been getting better news from other parts of its global business, as well, helping the company regain momentum after earnings and organic sales flattened out last year. Otis, the world's largest elevator maker, seems to have gotten past some stumbles in China early last year; UTC's security and fire-prevention businesses also are expanding abroad. "People are moving from the farms to the cities, which drives tremendous demand for our products," says Chênevert, who became CEO in 2008. The company gets 60% of its revenues from overseas.

Convinced that UTC had weathered its tough stretch, Deane Dray, an analyst at Citi Research, upgraded the stock last month to Buy from Neutral, noting that it is set up "well for a period of outperformance." His price target is $110, about 18% above Friday's closing price of $92.63 Although the shares are up 30% since Barron's wrote favorably about the company 2½ years ago ("Quiet Giant," Oct. 4, 2010), they've lagged behind the S&P 500's 35% rise. After posting a meager two-cent gain, to $5.35 a share, in 2012, UTC's earnings should gain nearly 15%, to $6.15 a share, this year, says Dray. Based on his forecast, the shares trade at a reasonable 15 times earnings, a discount to its peer group's 16.

THE PAYOFFS FROM THE Goodrich deal are tangible. United Technologies recently said it expects the annual cost savings from combining Goodrich with its existing aerospace businesses will hit $500 million by 2016. That's up from a previous estimate of $400 million and well above the $63 million in savings realized in 2012. These arise from combining procurement, staffing, and manufacturing plants.

William Blair's Heymann, who believes the stock can top $120 within 18 months, has done the math on how much distance UTC has put between itself and rivals GE and Honeywell. By his estimate, UTC can supply 65% to 70% of a commercial airliner, versus roughly 40% for GE and 35% for Honeywell. "GE and Honeywell didn't do anything wrong," says Heymann. "They just don't have the scope that United Technologies does." The breadth allows the company not just cross-selling opportunities but also the ability to create integrated parts that weigh less and save the airline money. It also saves time for customers "who don't have to go buy from 10 different suppliers," says Chênevert.

AFTER ITS RECENT TRANSITION, the Hartford-based company, which generated $57.7 billion in revenue last year, has a stronger balance sheet. It has raised more than $4 billion in the past year or so by divesting nonessential businesses, including rockets and wind turbines. The company has already paid down about one-third, or $5.5 billion, of the debt it incurred from the Goodrich deal.

Chênevert says the plan is to bring debt as a share of capital, currently about 46%, down to its historical levels in the low 30% range—a very reasonable goal given the company's strong free cash flow, which totaled $5.2 billion last year. The company has continued to support its dividend, currently $2.14 a share, for a respectable yield of 2.3%.

With more certainty about the future, UTC also has resumed share repurchases after a 15-month hiatus. The company targets at least $1 billion in buybacks this year.

Goodrich was by far Chênevert's biggest bet in 2011, but not his only important wager. He spent $1.5 billion to buy out Rolls Royce's position in IAE International Aero Engines, a consortium that makes the V2500 engine for the workhorse Airbus A320, a single-aisle aircraft typically used for shorter flights. The deal gave UTC a majority stake in IAE, which has delivered about 5,000 engines that will require maintenance and repairs and anticipates 3,000 more engine orders.

IAE is expected to add about 10 cents a share to earnings this year, its first positive contribution.

No doubt, Chênevert's legacy will hinge on the success of the Goodrich deal, but another big swing factor will be the PW1000G engine family, an ambitious project he pushed for aggressively during his days running Pratt & Whitney. Known as the geared turbofan, the engine differs from predecessors in that its fan spins at a slower speed than the low-pressure compressor and turbine do, creating more thrust. The bottom line is that the engine burns about 15% less fuel than those using the previous technology, is a lot quieter, cuts carbon emissions, and is lighter—all music to the ears of the airline executives.

Embraer is one of five manufacturers that have selected the GTF. Another is
BombardierBDRBF 2.354177614293221%Bombardier Inc. Cl BU.S.: OTCUSD1.9478
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(BDRBF) for its CS100, which is scheduled to begin commercial flights next year. Pratt & Whitney is the sole engine supplier for four of these single-aisle jets and the co-supplier for Airbus and its A320neo model. United Technologies estimates that the GTF program will generate at least $400 billion of sales over its life, including both the initial sales and after-market transactions like spare parts and maintenance. An engine typically lasts 30 years.

And with its stake in IAE, UTC should be able to sell more GTF engines.

ASIDE FROM ITS GROWING aerospace power, UTC is enjoying a rebound in several other key businesses. Otis, the company's most profitable division, mis-timed a price hike in China early last year as the country's economic growth was cooling. A tragic July 2011 escalator malfunction that killed one person and injured 30 others at a Beijing metro station also has shadowed the company. Operating profit margins fell to 20.8% last year, down from 22.6%, amid a 3% drop in sales.

But new orders in China increased 17% in the fourth quarter. Otis has been finding more robust growth in smaller cities away from the coasts. "You really have to customize your product; that's the big change at Otis," says Chênevert, who adds that installing lower-cost elevators in public housing is a growth opportunity in China.

The Bottom Line

Shares of United Technologies could rise 18%, to $110, in the next year or even a little further over 18 months as Goodrich kicks in more and other businesses rebound.

UTC's Sikorsky helicopter unit looks as if it will overcome the $157 million charge it incurred in last year's fourth quarter from cost overruns on a contract for search-and-rescue helicopters for the Canadian government. The helicopter business is otherwise solid, thanks partly to stronger demand from the oil and gas industry and an $8.5 billion contract it signed last year to deliver more Black Hawk and Sea Hawk helicopters to the U.S. armed forces.

At the same time, UTC Climate, Controls & Security, which combines Carrier's heating, air-conditioning, ventilation, and refrigeration businesses with the fire and security businesses, seems to have troughed, as its operating profit margin last year rose to 14.2%, up from 11.7% a year earlier, helped by the strengthening U.S. housing market. North American residential orders for its products jumped 20% in the fourth quarter.

As well as many of its components are working, the conglomerate still must cope with significant issues. It depends on military spending, which accounts for about 20% of sales, a key variable as the budget sequestration gets underway in Washington. The military portfolio includes the engine for the F-35, also known as the Joint Strike Fighter, whose rollout has been delayed by various production glitches. UTC expects to take a hit of 10 cents a share this year from the sequester, hardly a disaster. "Yes, there is going to be pressure to reduce some volume [for the military]," says Chênevert. "But our products have long lives. We don't have any end-of-life products."

Nearly every investment carries a Washington risk today. But UTC shares offer the likelihood of double-digit earnings gains in the next couple of years, driven by new and rebounding businesses, a solid dividend, and share buybacks. That's about as much certainty as a shareholder can desire.